Wealth: Costs of Wealth Management

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Global Trend Towards Disclosure of Kickbacks

Over the course of the last few years, we have been seeing an increasing number of clients demanding more transparency from their wealth managers. Since self-regulation obviously has not worked, laws and courts have stepped in to end the practice of kickbacks, or at least make them transparent to the client:

For the 30 member states of the European Economic Area (EEA) the “Markets in Financial Instruments Directive (MiFID)” provides a harmonized regulatory regime for investment services since 2007. The main objective is an increased transparency of financial markets and a better protection of client interests. Among other rules, wealth managers are now required to disclose to the clients all the kickbacks that they receive from third parties. Furthermore, firms offering investment services have to choose trading places offering a “best execution” (minimum costs, high speed, etc.) for the clients. The financial authorities of all member states had to incorporate MiFID in their rules and regulations for the local financial markets and services.

In Germany, the largest member of the EEA, the Federal High Court decided already in 2006 that wealth managers have to disclose all kickbacks and also inform their clients about the amount. Current cases take the regulation even further. Higher Regional Courts have decided that a client does not only have the right to get the kickbacks back, but also to get compensated for losses. The reasoning was that the client would not have chosen the wealth manager if he had known that there was a conflict of interests. Therefore, the court has shifted the burden of proof whether the client knew about any kickbacks on to the bank.

In Switzerland, arguably the global center of wealth management, the High Court decided, in 2006, that kickbacks belong to the clients. They can require a full disclosure and also return of all kickbacks the wealth manager received from third parties for managing their portfolio –for the last ten years of their client relationship.

In the USA the financial regulator SEC recommended in 2004 that brokers be required to disclose all commissions they receive, as well as fees their clients can expect to pay for a mutual fund. This was a reaction after the SEC found out that 14 out of 15 examined brokers got secret kickbacks from certain mutual funds for pointing clients to their funds. Even though the funds often produced lower returns and charged higher fees than other investments. The proposed rules would also require the wealth manager to provide clearer disclosures on their fees and expenses and on any conflicts of interest before an investor purchased shares in a fund. Since then various brokerages have been paid millions in fines for receiving mutual funds kickbacks. There is an ongoing criminal probe of kickbacks that companies allegedly paid to manage the Ney York State pension fund.

The trend to strengthen the rights for clients of wealth managers will continue. Clients should leverage their improved legal position and push their wealth managers for a full disclosure and reimbursement of kickbacks. Wealth managers are well advised to react proactively by informing clients about any kickbacks, reimbursing them and adopting a new business model dispensing with hidden commissions and charging the client outright fees for advisory services only.

Over the course of the last few years, we have been seeing an increasing number of clients demanding more transparency from their wealth managers. Since self-regulation obviously has not worked, laws and courts have stepped in to end the practice of kickbacks, or at least make them transparent to the client:

For the 30 member states of the European Economic Area (EEA) the “Markets in Financial Instruments Directive (MiFID)” provides a harmonized regulatory regime for investment services since 2007. The main objective is an increased transparency of financial markets and a better protection of client interests. Among other rules, wealth managers are now required to disclose to the clients all the kickbacks that they receive from third parties. Furthermore, firms offering investment services have to choose trading places offering a “best execution” (minimum costs, high speed, etc.) for the clients. The financial authorities of all member states had to incorporate MiFID in their rules and regulations for the local financial markets and services.

In Germany, the largest member of the EEA, the Federal High Court decided already in 2006 that wealth managers have to disclose all kickbacks and also inform their clients about the amount. Current cases take the regulation even further. Higher Regional Courts have decided that a client does not only have the right to get the kickbacks back, but also to get compensated for losses. The reasoning was that the client would not have chosen the wealth manager if he had known that there was a conflict of interests. Therefore, the court has shifted the burden of proof whether the client knew about any kickbacks on to the bank.

In Switzerland, arguably the global center of wealth management, the High Court decided, in 2006, that kickbacks belong to the clients. They can require a full disclosure and also return of all kickbacks the wealth manager received from third parties for managing their portfolio –for the last ten years of their client relationship.

In the USA the financial regulator SEC recommended in 2004 that brokers be required to disclose all commissions they receive, as well as fees their clients can expect to pay for a mutual fund. This was a reaction after the SEC found out that 14 out of 15 examined brokers got secret kickbacks from certain mutual funds for pointing clients to their funds. Even though the funds often produced lower returns and charged higher fees than other investments. The proposed rules would also require the wealth manager to provide clearer disclosures on their fees and expenses and on any conflicts of interest before an investor purchased shares in a fund. Since then various brokerages have been paid millions in fines for receiving mutual funds kickbacks. There is an ongoing criminal probe of kickbacks that companies allegedly paid to manage the Ney York State pension fund.

The trend to strengthen the rights for clients of wealth managers will continue. Clients should leverage their improved legal position and push their wealth managers for a full disclosure and reimbursement of kickbacks. Wealth managers are well advised to react proactively by informing clients about any kickbacks, reimbursing them and adopting a new business model dispensing with hidden commissions and charging the client outright fees for advisory services only.